Conceptual Framework and measurement
What financial reporting is for, what makes information useful, the five elements, and the measurement bases: historical cost and current value.
ACCA exams this helps with: FR Financial Reporting SBR Strategic Business Reporting See the ACCA map
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What it is: The Conceptual Framework is the set of ideas the IASB uses to write IFRS standards. It isn’t a standard itself.
The key idea: accounts exist to give investors, lenders and other creditors useful information for decisions. Information is useful if it is relevant and a faithful representation of what really happened.
Example. A company owns a building. Showing what it cost (historical cost) is reliable and easy to check. Showing what it’s worth today (fair value) is more relevant. The Framework explains both options.
Key words
- IASB
- The International Accounting Standards Board, which has written IFRS since 2001. Before that, the IASC wrote IAS (1973–2001).Example: IFRS 16 Leases was issued by the IASB; IAS 16 was originally issued by the IASC.
- Relevance
- Information that can make a difference to users’ decisions. Materiality is part of relevance, not a separate characteristic.Example: A big new loan is relevant to a lender deciding whether to lend more.
- Faithful representation
- Information that shows the substance of what happened: complete, neutral and free from error.Example: A lease is shown as a liability because the company really owes the payments.
- Historical cost
- Measuring an item at the price of the transaction that created it, less depreciation and impairment.Example: A machine bought for £120,000 three years ago, now at £48,000.
- Current value
- Measuring an item using conditions at the reporting date: fair value, value in use (or fulfilment value) and current cost.Example: The same machine at what it would cost to replace today.
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Where IFRS comes from
IAS were issued by the IASC from 1973 to 2001. In 2001 the new IASB took over, adopted the existing IAS, and has issued new standards called IFRS since. IFRS today includes IFRS, IAS, and interpretations from IFRIC and the older SIC.
New standards go through due process: set the agenda → plan the project → discussion paper → exposure draft → issue the standard → maintenance and monitoring.
Status of the Framework
The current Framework was issued in March 2018 (for companies, effective from 1 January 2020). It is not a standard: if a standard applies to a transaction, the standard wins. If no standard applies, management looks first at standards dealing with similar issues, then at the Framework’s definitions and concepts.
It has 8 chapters: the objective of reporting; qualitative characteristics; the reporting entity; the elements; recognition and derecognition; measurement; presentation and disclosure; capital and capital maintenance.
The objective
To provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.
Qualitative characteristics
| Type | Characteristic | In plain English |
|---|---|---|
| Fundamental | Relevance (including materiality) | Could it change a decision? Material = leaving it out or misstating it could influence users. |
| Fundamental | Faithful representation | Does it show what really happened (substance), completely, neutrally and without error? |
| Enhancing | Comparability | Can it be compared with other companies and other years? |
| Enhancing | Verifiability | Would independent experts broadly agree it is a fair depiction? |
| Enhancing | Timeliness | Is it available in time to affect decisions? |
| Enhancing | Understandability | Is it classified and presented clearly and concisely? |
The five elements
| Element | 2018 definition |
|---|---|
| Asset | A present economic resource controlled by the entity as a result of past events. (An economic resource is a right that has the potential to produce economic benefits.) |
| Liability | A present obligation of the entity to transfer an economic resource as a result of past events. (An obligation is a duty the entity has no practical ability to avoid.) |
| Equity | The residual interest in the assets after deducting all liabilities. |
| Income | Increases in assets, or decreases in liabilities, that increase equity, other than contributions from equity holders. |
| Expenses | Decreases in assets, or increases in liabilities, that decrease equity, other than distributions to equity holders. |
Measurement bases
| Group | Basis | What it means |
|---|---|---|
| Historical cost | Historical cost | The transaction price plus transaction costs, less depreciation and impairment. Doesn’t reflect value changes, except impairment. |
| Historical cost | Amortised cost | For financial assets and liabilities: future cash flows discounted at the rate set at initial recognition. |
| Current value | Fair value | The price to sell an asset, or transfer a liability, in an orderly transaction between market participants at the measurement date (an exit price). |
| Current value | Value in use / fulfilment value | The present value of the cash flows an entity expects from using an asset (or must pay to fulfil a liability). |
| Current value | Current cost | The cost of an equivalent asset today, including transaction costs. |
The old 1989 Framework had four bases: historical cost, current (replacement) cost, realisable (settlement) value and present value. It didn’t define fair value at all.
Where each standard uses which model
| Standard | Measurement |
|---|---|
| IAS 16 PPE, IAS 38 intangibles | Choice by class: cost model or revaluation model (gains to OCI) |
| IAS 40 investment property | Choice for all investment property: cost model or fair value model (all changes to P/L, no depreciation) |
| IAS 41 agriculture | No choice: fair value less costs to sell, changes to P/L |
| IFRS 9 financial instruments | Amortised cost, fair value through P/L, or fair value through OCI |
Historical cost or market value?
| Historical cost | Market-based (fair value) | |
|---|---|---|
| For | Easy to understand and produce; objective; backed by invoices; widely used (US GAAP is mostly historical cost) | More relevant; net assets closer to the company’s market value |
| Against | When prices rise, assets are understated, depreciation is too low so profit is overstated, ratios such as ROCE lose meaning, and dividends may be paid out of capital | Can be subjective; complex; costly (valuers and auditors) |
IFRS 13 sets out how to measure fair value, using a hierarchy of inputs: Level 1 quoted prices for identical items in active markets; Level 2 other observable inputs; Level 3 unobservable inputs. See IFRS 13.
Watch it explained
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Worked example
A machine with a 5-year life was bought 3 years ago for £240,000 (straight line, no residual value). A new replacement would cost £280,000 today. It will produce cash flows of £60,000 a year for its remaining 2 years. The discount rate is 10%.
| Measurement basis | Working | £ |
|---|---|---|
| Historical cost (carrying amount) | 240,000 × 2/5 | 96,000 |
| Value in use | 60,000 ÷ 1.10 + 60,000 ÷ 1.10² | 104,132 |
| Current cost | 280,000 × 2/5 (a new machine, 2 of 5 years left) | 112,000 |
Value in use: 54,545 + 49,587 = 104,132. Each basis gives a different number for the same machine. That’s why the choice of measurement basis matters.
Practice questions
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